Pressing China on the Yuan Won’t Work

In yet another attempt by the U.S. to force China to change its currency regime, senators on Tuesday introduced legislation that would require the government to impose duties on goods from countries that don’t address currencies deemed to be misaligned. In other words: China. The bill follows a war of words between the U.S. and China in recent days over the value of the Chinese currency, the yuan, which the senators only managed to fuel further. Sen. Debbie Stabenow said China’s currency practices were equivalent to “cheating,” while Sen. Sam Brownback promised that if China didn’t take corrective action, “we’re going to force them.”

The new bill clearly shows how politicized the yuan has become and the growing anger China’s currency policies are creating around the world. Many U.S. politicians and economists believe China purposely sets the yuan at an artificially cheap level to promote its exports at the expense of those from other economies. Though that may or may not actually be the case, Beijing is nonetheless a big, fat political whipping boy, an easy target for Americans worried by high unemployment and an uncertain recovery to blame for the country’s economic woes.

But the problem is that such efforts by the U.S. to pressure China to reform the yuan simply won’t work, and may actually hurt, not help, the U.S. economy. Here’s why:

First, there is absolutely no way that China will cave in to such public haranguing and reform their currency system. The Chinese are highly sensitive to criticism and pressure on this front, as shown by prickly statements from Premier Wen Jiabao over the weekend, and threats from the U.S. Senate only corners Beijing into a position where it becomes politically difficult for the government to take any action. If China reformed its currency regime under such circumstances, it would appear as an embarrassing sign of weakness both at home and abroad. Washington should fully understand that, since the U.S. government would do (and has done) exactly same thing on other bilateral issues. Just in recent weeks, China was tossing all kinds of angry rhetoric at Washington about Obama’s planned meeting with the Dalai Lama, considered a separatist by Beijing, but that didn’t cause the White House to cancel the powwow. And imagine the political fallout if Obama had called it off in the face of Chinese opposition. It would be like bowing to the Saudi king times ten. If Washington wants China’s cooperation on sensitive economic issues, it has to become more sensitive to Chinese political realities.

Second, a stronger yuan isn’t a panacea to American economic problems. There is a belief that if China allowed the yuan to appreciate, U.S. industry would become more competitive and the giant trade deficit with China would evaporate. But that could very well be wishful thinking. When the yuan was appreciating against the U.S. dollar, from 2005 to 2008, the U.S. trade deficit with China actually increased. A stronger yuan may be only one element of a much greater slate of changes necessary to reduce the U.S. trade deficit with China, which includes raising the U.S. savings rate and bringing down the level of consumption in America.

In fact, a stronger yuan might actually be detrimental to the U.S. economy in certain key ways. The reality Americans have to digest is that China manufacturers a tremendous share of the world’s basic consumer products, from toys to clothes to consumer electronics, and that will likely continue to be true for the foreseeable future, whatever the value of the yuan. Factories in many industries just can’t pack up and move house every time a currency fluctuates. China also has competitive advantages beyond its currency, from excellent infrastructure to low wages, which will keep its factories humming even if the yuan strengthens. Therefore, all a more expensive yuan might achieve is making all of those Chinese goods at your local Wal-Mart more expensive – and that’s not good for a U.S. consumer already burdened by debt and job instability.

Third,the U.S. cannot reverse the greater trends set in motion by globalization by altering the value of the yuan. Let’s assume for a moment that the yuan strengthens and as a result certain exports from China become less competitive. Such a process might change the balance of trade between the U.S. and China. However, that doesn’t mean jobs will flow back to the U.S. in certain basic industries, nor does it mean the overall U.S. trade deficit will be eliminated. If China morphs into a more expensive place to manufacture (which will inevitably happen over time) there is no shortage of other countries with lower costs that can replace China as a base for exporters of consumer goods. Vietnam, for example, has already been a beneficiary of escalating labor costs in China. Factories looking for cheaper wages have been shifting to that nation in recent years. Exporters might move to India, Indonesia, Bangladesh, and so on. All of these countries can offer far, far lower costs than the U.S. The reality is that a more expensive yuan would have a much greater impact on the rest of the developing world than it would on the U.S. economy.